Betting on Retail

Last week, I discussed the role that confidence plays in the stock market’s performance. In the short run, investor sentiment can be the single most important factor driving the market. Momentum is nothing more than a preponderance of investor sentiment leaning one way or the other.

That is why I pay attention to the Consumer Confidence Index (CCI) published monthly by The Conference Board. Although driven by different dynamics, a change of direction in the CCI tends to correlate highly with the behavior of the stock market.

Last week, the latest CCI data revealed that consumer confidence spiked in September after declining the previous three months. The CCI jumped from a reading of 86.3 in August to 101.8 in September.

Typically, the CCI changes a few percentage points from month to month. The fact that it both reversed direction and moved more than fifteen percentage points in a single month is highly unusual.

That begs the question: What happened over the past 30 days to cause such a profound change in consumer confidence? The number of survey respondents agreeing that jobs are plentiful increased in September, while those that feel job are hard to get decreased.

However, the jobs data over the past month has not been encouraging. The number of Americans filing for new unemployment claims leveled off at more than 800,000 per week.

Regardless of why so many survey respondents are feeling better about the economy, that optimism carried over to the stock market. Although the survey results were released on September 29, the cutoff date for collecting responses was September 18.

Dichotomy in Confidence

That date coincides with when the stock market ended its recent slide and started to rally. After bottoming out near 3,200 on September 24, the S&P 500 Index rallied 4% over the next week.

More revealing is the performance of consumer retail stocks, which are strongly affected by consumer confidence. That may explain why Target (NYSE: TGT) gained 10% over the last three weeks of September.

However, there are several consumer stocks that have yet to recover. Electronics retailer Best Buy (NYSE: BBY) ended the month about where it started while Walmart (NYSE: WMT) actually lost ground in September.

If consumer confidence really is on the upswing heading into the holiday gift-buying season, most retail stocks should already be on the rise. The fact that they are not suggests Wall Street is more concerned about third-quarter results yet to be released than it is letting on.

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The dichotomy in confidence between individual consumers and Wall Street money managers creates an investment opportunity. One group will be proven right and the other wrong.

In this case, I am siding with the consumers. I do not believe that the jobs situation has improved enough to warrant a stock market rally. However, I suspect that employed consumers will spend more money than usual this holiday season to offset nearly a year’s worth of sacrifice.

If that turns out to be the case, correctly identifying which retailers will benefit the most could be quite lucrative. Alternatively, you could make a bet on the entire sector by owning shares of the SPDR S&P Retail ETF (XRT).

The top five holdings of this fund are (NSDQ: OSTK), Etsy (NSDQ: ETSY), Rite Aid (NYSE: RAD), Big Lots (NYSE: BIG), and Grocery Outlet (NSDQ: GO).

Blue Light Special

After peaking above $53 at the start of September, XRT fell below $50 four weeks later (circled in the chart below). That performance seems to contradict the consumer confidence survey results.

If you trust the CCI results then right now should be a good time to gamble on retail stocks before their Q3 results have been released. If you are feeling especially frisky, you could buy call options on XRT. A call option increases in value as the price of the underlying security rises.

For example, last week while XRT was trading near $50 you could buy a call option that expires on January 15 at the $46 strike price for $6. For this trade to be profitable at expiration, XRT must rise above $52.

If XRT makes it up to $55 by the time this option expires, the return on investment would be 50% ($3 profit divided into $6 cost). If you own shares of the fund, the gain would be 10% ($5 profit divided into $50 cost). Of course, you can lose more money trading options, too. That is why you must know what you are buying and how much risk and you are willing to take.

The subject of risk brings me to my colleague Dr. Stephen Leeb, the chief investment strategist of The Complete Investor. Dr. Leeb has coined a term that explains the mounting risks in financial markets. He calls it “Reset 2020,” and he believes it signals a paradigm shift in how equities will be valued in the years to come. To learn more about this shift and how to profit from it, click here.